Economic analysis

Looking for the root causes of inequality in all the wrong places

Why the wage-productivity 'disconnect' does not explain increased inequality

This chart from the Economic Policy Institute is taken from its list of the “most important charts for 2013”:




This chart shows real wages tracking labour productivity fairly well until the 1970s, after which real wages stagnate even as productivity continues to rise. This is one of those times where it’s important to check the relevant Canadian data before concluding that we have the same problem.

The first part of my series of posts on productivity outlined how increased productivity is passed on to workers in the form of higher real wages, and it had a chart showing how real wages track productivity fairly closely in the US. But it turns out that the choice of the price level used to calculate real wages (real wage = nominal wage / price level) is crucial. The price index used to calculate real wages in the EPI chart is the CPI, and that makes sense: what matters to households is their purchasing power. But the theory of the firm uses producer prices to calculate the real wage series that tracks productivity.

The choice of price index—consumer or producer prices—to calculate real wages yields very different patterns:


[Data are series OPHPBS, HCOMPBS, IPDBS and CPIAUCSL from the FRED database. The graph looks a little different because the EPI uses cumulative growth rates instead of levels.]

Productivity gains in the U.S. have been passed on to wages, although less so during the weak U.S. labour market of the last five years. The real problem is that the prices of what U.S. workers are producing are increasing more slowly than the prices of what they’re buying.

Here is the same chart for Canada:


[Data are taken from Cansim Table 383-0008.]

There was a time when Canada had the same problem the U.S. does. Up until the mid-1990s, consumer prices were rising faster than producer prices, so real wages stagnated. But the last 20 years has been a story in which consumer and producer prices grew at roughly similar rates, so productivity gains in Canada have resulted in increased purchasing power.

The problem with the EPI chart is that it purports to show the “root cause” for increasing income inequality in the U.S. This interpretation is clearly wrong: Canada had similar increases in income inequality during this period even though real wages (as calculated using the CPI) continued to track productivity.